Unit 2

Why is it unwise to use savings vehicles for investment goals or investment vehicles for savings dollars?

Why is it important to consider both current income and total return when choosing an investment to match a financial goal?

Why is it important to consider rate of return and real rate of return when choosing an investment to match a financial goal?

Why is it important to consider the risk/rate-of-return relationship when choosing an investment to match a financial goal?

Well-planned diversification of an investment portfolio can reduce much of the total risk associated with investing. Name three approaches to diversification.

Why does diversification have the potential to both increase and decrease investment returns?

How do you implement a dollar-cost averaging investment strategy? What are the benefits of such an approach?

Based on the principles of time-value of money, what advice would you give a young person who asserts s/he cannot afford to invest today, but prefers to wait until later when earnings increase?

Relate the asset allocation models shown in Figure 4 to the Compound Annual Rate of Return and the Pyramid of Investment Risk, shown in Figures 1 and 2, respectively. Assuming any truth to the proposition, “the higher the risk, the higher the return,” which asset allocation model would be expected to have the highest return?

When considering the four factors that influence your choice of asset allocation, why might it be unwise to use a money market mutual fund as the primary investment vehicle for accumulating retirement funds?

Investment earnings may be taxable, tax-deferred, or tax exempt. How does this status affect the choice of investment strategies and the applicable financial goal(s)?

It is important to understand your own investment preferences. However, it is also important that the preferences shown in Figure 5 are considered when matching investment products with financial goals. Use the principles introduced in this unit to explain this relationship.

Just Do It!! Acting on What You Learned

Because Internet sites change frequently, the uniform resource locator (URL) for the specific tool or page is not given below. Instead, the URL for the site, and instructions for navigating within the site are provided. It is our hope that this method will encourage you to explore and learn from the site, and more importantly, avoid the message: “Error: Site Not Found.”

Disclaimer: References to commercial sites are not an endorsement of the company or the financial products or services offered. These sites are included only because of their educational value; sites provided by competing companies may offer similar benefit. We encourage you to explore other sites of your choice.

1. Visit the Fund Selector or Fund Quickrank pages at www.morningstar.com to view mutual funds ranked by total return over different time periods. Do the same mutual funds consistently appear on the lists? Or, use the Stock Selector or Stock Quickrank pages to review total returns for individual common stocks. Assuming you had the money, did you identify a mutual fund or stock you would purchase? What was the range of total returns reported? Were you surprised?

2. Review investment or retirement statements for your own accounts. Is the total return reported? If not, use the Morningstar Internet site above to determine the total return.

3. Many of the investment company Internet sites provide excellent educational pages. For additional information and analytical tools related to this unit, see the following:

Take the Risk Tolerance Quiz found on the Rutgers Cooperative Extension Web site

6. Critically evaluate your personal situation using one or more of the following questions:

Have you (in consultation with other members of your household) established, your savings and investment goals?

Given your time horizon, risk tolerance, and knowledge of historical rates of returns, what asset allocation model might be most appropriate for your investment goals? How does that model match your current allocation?

Are your current holdings diversified? Which strategies have you used?

If you are not currently dollar-cost averaging into one or more investments, what changes would be necessary in your monthly cash management plan to accommodate this strategy?

What are the tax implications of your current investment situation? Have you considered the tax consequences of investment earnings in your choices?